Caution still in order for bears and bulls

AviGilburt

Avi Gilburt is author of
ElliottWaveTrader.net, a live trading room and member forum focusing on
Elliott Wave market analysis. Avi emphasizes a comprehensive reading of charts
and wave counts that is free of personal bias or predisposition. A lawyer and
accountant by training, he is also managing member of Gilburt Financial
Services, LLC, which provides financial markets analysis and consulting. His
Elliott Wave analysis appears frequently on sites such as SeekingAlpha, where he
is a certified contributor, and
TheTechTrader.com with Harry Boxer.

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It seems that, while I was out for the religious holiday, the market moved up into the blue box target I provided you in the Weekend Analysis, and reversed quite strongly. While such a reversal can still be counted as the top of a red wave (2), that very bearish perspective comes into question once the market is able to move over the 1446
US:ESZ2
level. If it is able to move over that level, then the larger bearish perspective calling for the middle-to-low 1300 region would become much less likely.

Currently, there are two other possibilities that still remain. The first is a larger leading diagonal which still requires one more 3-wave rally up toward the 1455 region, without breaking down below 1431ES. If that 3 wave rally were to happen, then we would likely see a deep retracement, during which we can buy long positions for a rally toward 1500ES.

The second possibility is a larger 4th wave which can still climb as high as the 1456-1459ES region, and provide us with a strong decline to the 1414ES region. This, too, would set up a long trade toward the 1500ES region. But the difference between the rally over 1456ES and the one in the diagonal possibility is that this would be a 5-wave c-wave rally, and the diagonal scenario would only be a 3-wave rally.

Also, in an impulsive wave pattern, the 3rd wave cannot be the shortest wave pursuant to Elliott Wave rules. In the leading diagonal possibility on the chart, wave 3 was shorter than wave 1. It would mean that any move from here that takes us directly over the 1456ES level would tell us that we are not dealing with a leading diagonal since wave 3 would then be the shortest wave. Therefore, a move up that tops between the 1456-1459ES region would make it more likely that we are heading down in a (c) wave towards the 1414ES region. However, a move through 1459ES and over 1462ES would likely mean we are heading up to the 1500 region to potentially complete a larger a-wave of the 5th wave from the June lows without a very deep retracement.

IWM: A chart screaming “caution”

For those who are getting bullish already, I would really caution you that the risk has still not come out of the markets just yet. As one glaring example, please take a look at the IWM chart linked at the end of the column. You will see that after the market spiked just above the last-year high, it has come back down quite strongly and has even broken down below its uptrend channel. This is never a constructive development, especially since it has been consolidating BELOW this channel. In fact, the IWM can still rally back towards the 84.50-85 region and still decline towards the 80-81 region to complete a larger 4th wave. So, this chart is telling us clearly that caution is still warranted.

Have you been completely frustrated by this market since June?

After reading some of your comments over the last several days, I sense frustration from some of you during the recent whipsaw action in the market over the last week. But, in truth, this is not really much different than the action we have seen during the entire rally since June.

So, why has this market been so difficult since June - and especially over the last several weeks? Even though we have done quite well with navigating the significant and treacherous up and down swings in this market since June, there is not a single person among us that has not seen days when they expected a gap up, only to be confronted with a gap down, or vice versa. So, why has this been the case?

The reason is that the nature of the rise since June has been best counted as 3 wave advances with 3 wave declines. Normally, impulsive waves are 5 wave moves and 3 wave moves are corrective waves. Yet, we have only had impulsive waves in 3 wave moves. We actually identified this in the very early stages of the rally — actually, around the end of June, which caused us to classify this larger pattern as a diagonal quite early in the pattern. This has allowed us to exit the market after 3 wave advances and look for 3 wave declines for re-entry. This is why we have been able to successfully navigate the rally since June. Clearly, this was much more difficult trading than the standard 5 wave advances followed by 3 wave corrections we normally see.

However, as we move higher, it has become more difficult. Where it is inordinately more difficult is when attempting to determine if a 3 wave move off a low is a corrective rally setting up a further decline in the larger correction, or if it is the beginning of the next 3 wave rally phase in the market. This is why I have continually been focusing on the Elliott Wave derived Fibonacci levels of support and resistance to assist us in this determination.

And as we move higher and higher, the risks will rise as well, as a 5th wave can always truncate and not reach the ideal target extension. Ideally, we have had a long-time target at the 1574ES level. This would mean that the a-wave of the 5th wave should take us over 1500ES, and potentially to 1523ES, and, after a b-wave pullback, begin a c-wave rally to the 1574ES target top of the 5th wave.

So, if this market does move higher into the end of the calendar year, it will likely be classified as a 5th wave, which are often technically much weaker than the 3rd wave we have recently completed. This means that we will likely be rising on negatively diverging technicals, and moving towards a significant top, which can see a very strong reversal, which is often experienced at the conclusion of a diagonal. So, when we do finally see confirmation that we have begun the final wave up, the question one always has to ask themselves is how much risk you want to take as we approach a major topping region.

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